Are Raffle Prizes Taxable to Employees?
An employee prize is generally considered taxable compensation. Understand how the IRS views these awards and the specific financial duties required of employers.
When an employer provides a raffle prize to an employee, it is considered taxable compensation. This applies whether the prize is cash, a gift card, or a non-cash item like electronics or a vacation. According to Internal Revenue Code Section 61, all forms of compensation are subject to income tax unless a specific exclusion applies. The Internal Revenue Service (IRS) views most gifts and awards from an employer to an employee as a form of payment for services rendered, so the value of the prize must be included in the employee’s gross income.
Determining the Taxable Value of a Prize
The amount included in an employee’s income is the Fair Market Value (FMV) of the prize on the date it is received. FMV is defined as the price the item would sell for on the open market. It is not necessarily what the employer paid for the item. For example, if an employer purchases a tablet at a discount, the taxable amount for the employee is the full retail price that anyone would have to pay for it.
The application of FMV varies based on the type of prize. For a cash prize, the value is simply the amount of cash given. Gift cards and gift certificates are treated as cash equivalents, and their value is the face amount of the card. For non-cash items, such as electronics, merchandise, or a vacation package, the FMV is their retail value.
Employer Withholding and Reporting Obligations
Once the value of a prize is determined, the employer must treat it as supplemental wages. Supplemental wages are payments made to an employee outside of their regular pay, and they are subject to specific tax withholding rules. The employer is responsible for withholding federal income tax, as well as Social Security and Medicare taxes (collectively known as FICA taxes), from the value of the prize.
For cash prizes, the withholding process is straightforward. For non-cash prizes, the employer has a couple of options to collect the necessary taxes. The employer can collect the tax amount directly from the employee, or they can add the value of the prize to the employee’s regular paycheck and withhold the taxes from the combined total. Some employers may also choose to “gross-up” the payment, which involves the employer paying the taxes on behalf of the employee, which increases the employee’s total taxable income.
The FMV of the prize must be reported on the employee’s annual Form W-2, Wage and Tax Statement. The value is included in the totals for Box 1 (Wages, tips, other compensation), Box 3 (Social Security wages), and Box 5 (Medicare wages and tips).
The De Minimis Fringe Benefit Exception
A narrow exception to the rule of taxability exists for what the IRS calls de minimis fringe benefits. A benefit qualifies as de minimis if its value is so small and it is provided so infrequently that accounting for it would be unreasonable or administratively impracticable. This exception is detailed in IRS Publication 15-B. The IRS has not set a specific dollar amount, but items valued over $100 are generally not considered de minimis.
Examples of items that might qualify as de minimis benefits include a holiday turkey, a bouquet of flowers for a special occasion, or occasional coffee and donuts. The infrequency of the benefit is a factor in the determination. For instance, occasional tickets to a sporting event might qualify, but season tickets would not.
Cash and cash equivalents can never be excluded as de minimis benefits, regardless of the amount. This means that gift cards, even for a small amount like $10, are always considered taxable income to the employee. The reasoning is that cash and its equivalents are easily accounted for, so the “administratively impracticable” standard is never met.